Education

2.  State Bank of Pakistan Act 1956
 Banking Companies Ordinance 1962
 Foreign Exchange Regulations Act 1947
 Financial Institutions (Recovery of Finance) Ordinance
2001
 Prudential Regulation
 Financial Sector Reforms

3.  Introduction
◦ In general prudential regulations are the standards that require
firms to control risks and hold adequate capital.
◦ The prudential regulation is regulation of deposit-taking
institutions and supervision of the conduct of these institutions
and set down requirements that limit their risk-taking
◦ The aim of prudential regulation is to ensure the safety of
depositors' funds and keep the stability of the financial system

4.  Prudential regulations can be grouped into two categories,
◦ Micro prudential supervision refers to firm-level oversight
or financial regulation by regulators of financial institutions,
"ensuring the balance sheets of individual institutions are
robust to shocks“
◦ Macro prudential regulation characterizes the approach to
financial regulation aimed to mitigate the risk of the
financial system as a whole (or "systemic risk").

5.  Uniform Banking system:
◦ Main objective of any regulation is to bring uniformity in desired sector. Prudential
regulations are aimed at uniform banking system. Prudential regulations serve this purpose
for Banking sector.
 Bank Licensing:
◦ Tougher bank licensing procedures
◦ Where regulators are subject to much political pressure, implementing a tougher licensing
policy may be a relatively easy option.
◦ licensing policies should not be so restrictive as to stifle entry from banking investors able
to serve small and medium sized enterprises which are often poorly served at present by
the international banks in low income developing countries.
 Regular monitoring:
◦ Prudential regulations established as a system of regular monitoring on commercial banks
 Protect deposits:
◦ Protect deposits is main concern of not only banks but regulatory and monitory authorities
as well. Main focus of prudential regulations is on the safety and soundness of deposit
takers to protect deposits, which cannot be left on the mercy of commercial bank’s
management

6.  Credit risks:
o Prudential regulations have been framed to regularize and control commercial bank’s
advancing function.
o Free license cannot be given to them to lend money at their will.
 Overcome deficiencies:
o Weak accounting standards, the poor quality of financial information available, acute
shortages of necessary professional skills, poor public sector pay, the politicization of
regulatory processes and the difficulty in enforcing bureaucratic and legal regulations which
also is partly due to political interference in the regulatory process.
 Economic Crises:
o The objective of prudential regulation is to protect the stability of the financial system and
control possible effect of economic crises on banking sector.
 International Co-ordination:
o The prudential reforms in developing countries are usually based on upgrading banking laws
in accord with international “best practice”, such as bringing minimum capital requirements
in line with the BASEL(BASEL I,II, and Now BASEL III) Capital Accord and strengthening
the supervisory capacities of regulatory agencies.
 World Bank’s priority:
o Bank supervision and regulations featured World Bank financial sector adjustment loans in
the 1990s.

7.  Help in risk management
 Punish reckless and abusive management.
 Higher minimum capital requirements for banks would mean
that bank owners, with more of their own capital at risk, would
have stronger incentives to ensure that their bank is managed
prudently.
 By increasing entry barriers into the banking industry, higher
capital requirements would enhance the franchise value of
banks.
 Developing countries’ banks face more risks than do those in
OECD countries because their economies are less diversified
and more volatile.

8.  Risk Management (R)
 Corporate Governance (G)
 Customer Due Diligence and Anti Money Laundering
(M)
 Operations (O)
Prudential regulations are very long and detailed,
these can be completely studied in available booklets or
can be seen from following link;
http://sbp.org.pk/publications/prudential/index.htm

9. REGULATION: R-1# LIMIT ON EXPOSURE TO A SINGLE PERSON/GROUP;
o The total outstanding exposure (fund based and non-fund based) by a bank/DFI to any single
person shall not at any point in time exceed 30% of the bank’s/DFI’s equity as disclosed in
the latest audited financial statements, subject to the condition that the maximum outstanding
against fund based exposure does not exceed 20% of the bank’s/DFI’s equity.
REGULATION: R-2 # LIMIT ON EXPOSURE AGAINST CONTINGENT LIABILITIES;
o Contingent liabilities of a bank/DFI shall not exceed at any point in time 10 times of its
equity. There are certain items which shall not constitute contingent liabilities for the purpose
of this regulation, these have been mentioned there in.
REGULATION: R-3 # MINIMUM CONDITIONS FOR TAKING EXPOSURE
o While considering proposals for any exposure (including renewal, enhancement and
rescheduling/restructuring) exceeding such limit as may be prescribed by State Bank of
Pakistan from time to time (presently at Rs 500,000), banks/DFIs should give due weightage
to the credit report relating to the borrower and his group obtained from Credit Information
Bureau (CIB) of State Bank of Pakistan.
 REGULATION: R-4 # LIMIT ON EXPOSURE AGAINST UNSECURED FINANCING
FACILITIES
o Banks/DFIs shall not provide unsecured/clean financing facility in any form of a sum
exceeding Rs 500,000/- (Rupees five hundred thousand only) to any one person

10. REGULATION: R-5 # LINKAGE BETWEEN FINANCIAL INDICATORS OF THE
BORROWER AND TOTAL EXPOSURE FROM FINANCIAL INSTITUTIONS
o While taking any exposure, banks/DFIs shall ensure that the total exposure (fund- based
and/or non-fund based) availed by any borrower from financial institutions does not exceed
10 times of borrower’s equity as disclosed in its financial statements
REGULATION: R-6 # EXPOSURE AGAINST SHARES/TFCs AND ACQUISITION OF
SHARES
o Banks/DFIs shall not own shares of any company/scripts in excess of 5% of their own equity.
Further, the total investments of banks in shares should not exceed 20% of their own equity.
REGULATION: R-7 # GUARANTEES
o All guarantees issued by the banks/DFIs shall be fully secured, except in the cases where it
may be waived up to 50% by the banks/DFIs at their own discretion provided that banks/DFIs
hold at least 20% of the guaranteed amount in the form of liquid assets as security.
REGULATION: R-8 # CLASSIFICATION AND PROVISIONING FOR
ASSETS LOANS/ADVANCES:
o Banks/DFIs shall observe the prudential guidelines in the matter of classification of their
asset portfolio and provisioning there-against. Investment portfolio in ‘Held for Trading’ and
‘Available for Sale’ and other assets will be subject to detailed evaluation for the purpose of
their classification keeping in view various subjective and objective factors

11. REGULATION: R-10 # FACILITIES TO PRIVATE LIMITED COMPANY
o Banks/DFIs shall formulate a policy, duly approved by their Board of Directors, about
obtaining personal guarantees of directors of private limited companies. Banks/DFIs may, at
their discretion, link this requirement to the credit rating of the borrower, their past
experience with it or its financial strength and operating performance.
REGULATION: R-11 # PAYMENT OF DIVIDEND
o Banks/DFIs shall not pay any dividend on their shares unless certain specified requirements
are being fulfilled.
REGULATION: R-12 # MONITORING
o While extending fund based facilities to borrowers against hypothecation of stock and/or
receivables on pari-passu basis, banks/DFIs shall obtain monthly statements from borrowers
that contain a bank-wise break-up of outstanding amounts with the total value of stocks and
receivables there-against.
o Pari passu is a Latin phrase that literally means "with an equal step" or "on equal footing". It is sometimes translated as
"ranking equally",["hand-in-hand", "with equal force", or "moving together", and by extension, "fairly", "without partiality".
REGULATION: R-13 # MARGIN REQUIREMENTS
o Banks/DFIs are free to determine the margin requirements on facilities provided by them to
their clients taking into account the risk profile of the borrower(s) in order to secure their
interests. However, this relaxation shall not apply in case of items, import of which are
banned by the Government.
o Banks/DFIs are advised not to open import letter of credit for these items in any case till such
time the lifting of ban on any such item is notified by the State Bank of Pakistan.

12. REGULATION: G-1 # CORPORATE GOVERNANCE/BOARD OF DIRECTORS AND
MANAGEMENT
o Guidelines have been laid down which are required to be followed by banks/DFIs incorporated in Pakistan.
o Code of Corporate Governance’ issued by the Securities & Exchange Commission of Pakistan (SECP)
2002 and revised in 2012.
o Prudential Regulations and the instructions/guidelines issued by the State Bank of Pakistan. Foreign banks
are required to adhere to these guidelines wherever feasible and applicable. However, they need not
necessarily seek approval of their Board of Directors, as stipulated in the case of local banks/DFIs:
REGULATION: G-2 # DEALING WITH DIRECTORS, MAJOR SHARE-HOLDERS
AND EMPLOYEES OF THE BANKS/DFIs
o Banks/DFIs shall not enter into leasing, renting and sale/purchase of any kind with their directors,
officers, employees or such persons who either individually or in concert with family members beneficially
owns 5% or more of the equity of the bank/DFI.
o This restriction does not apply in case of purchase of vehicles by the paid directors, officers or employees
of the banks/DFIs which remained in their own use, provided such sale is covered under the employees
service rules duly approved by the Board of Directors of the banks/DFIs and is effected by the banks/DFIs
at least at book value at the date of such transaction.

13. REGULATION: G-3 # CONTRIBUTIONS AND DONATIONS FOR CHARITABLE,
SOCIAL, EDUCATIONALAND PUBLIC WELFARE PURPOSES
o Banks/DFIs shall strictly observe the following rules in the matter of making any
donation/contribution for charitable, social, educational or public welfare purposes.
REGULATION: G-4 # CREDIT RATING
o With a view to safeguard the interest of prospective investors, depositors and creditors, it
shall be mandatory for all banks/DFIs to have themselves credit rated by a credit rating
agency on the approved panel of the State Bank of Pakistan.

14.  REGULATION: M-1 # CUSTOMER DUE DILIGENCE
(CDD)
◦ With the view to preserve integrity and safety of the financial system, it is
expedient to prevent the possible use of the banking sector for money laundering
and terrorist financing.
◦ Due Diligence/Know Your Customer (CDD/KYC) requires special attention and
concrete implementation.
◦ Minimum guidelines are required to be followed by banks/DFIs to avert the risks
posed by the money laundering and terrorist financing.
◦ However, banks/DFIs are free to take additional measures in line with Financial
Action Task Force Recommendations.

15. REGULATION: M-2 # ANTI-MONEY LAUNDERING MEASURES
o Banks/DFIs are advised to follow the guidelines to safeguard themselves
against their involvement in money-laundering activities, and other
unlawful trades. These will add to or reinforce the precautions, banks/DFIs
may have been taking on their own in this regard.
a) Perception about Illegal Activities
b) Specific Vigilance
c) Banks/ DFIs are required to include accurate and meaningful
originator information (name, address and account number) on funds
transfers. However, banks/ DFIs may, if satisfied, substitute the
requirement of mentioning address with CNIC, Passport, Driving license or
similar identification number for this purpose.

16. d) Beneficiary financial institutions shall adopt effective risk-
based procedures for identifying and handling wire transfers that are
not accompanied by complete originator information. Wire transfers
with incomplete originator information may be seen with suspicion
which may require reporting to FMU or termination of the
transaction.
e) Banks/DFIs shall not allow personal accounts to be used for
business purposes except proprietorships, small businesses and
professions where constituent documents are not available.
f) For an effective implementation of banks’/DFIs’ policy and
procedures relating to anti money laundering/other unlawful trades,
suitable training be imparted to members of staff and they be
informed of their responsibility in this regard.

17. REGULATION: M-3 # RECORD RETENTION
o The records of transactions and identification data etc. maintained by banks/DFIs occupy
critical importance as for as legal proceedings are concerned.
o The prudence demands that such records may be maintained in systematic manner with
exactness of period of preservation to avoid any set back on legal and reputational fronts.
o Banks/DFIs shall therefore, maintain, for a minimum period of five years, all necessary
records on transactions, both domestic and international. The records so maintained must be
sufficient to permit reconstruction of individual transactions (including the amounts and types
of currency involved, if any)
o Banks/DFIs shall, however, retain those records for longer period where transactions relate to
litigation or are required by the Court of law or by any other competent authority.
REGULATION: M-4 # CORRESPONDENT BANKING
o The banks/DFIs shall gather sufficient information about their correspondent banks to fully
understand the nature of their business. Factors to consider include:
o Know your customer policy (KYC)
o Information about the correspondent bank’s management and ownership
o Major business activities
o Their location
o Money laundering prevention and detection measures
o The purpose of the account
o The identity of any third party that will use the correspondent banking services
o Condition of the bank regulation and supervision in the correspondent’s country

18. REGULATION: M-5 # SUSPICIOUS TRANSACTIONS
o The banks/DFIs should pay special attention to all complex,
unusually large transactions, and all unusual patterns of
transactions, which have no apparent economic or visible
lawful purpose.
o The back ground and purpose of such transactions should, as
far as possible, be examined, the findings established in
writing, and be available to help the relevant authorities in
inspection and investigation.

19. REGULATION: O-1 # UNDERTAKING OF CASH PAYMENTS OUTSIDE
THE BANK’S AUTHORIZED PLACE OF BUSINESS
o Banks shall not undertake any business of cash payments, other than the authorized
place of business, except through the installation of Automated Teller Machine
(ATM).
o Banks desirous of providing the facility of withdrawal through Authorized
Merchant Establishments at various Points of Sale (POS) may do so upto a
maximum cash limit of Rs 10,000/- For this purpose, adequate and suitable security
measures should be put in place for cash feeding and safety of the machines.
o Banks may do collection and payment of cash for their prime customers through
cash carrying companies registered with concerned Government department. This
facility should, however, be provided through designated branches of the banks and
after the banks have devised procedures including necessary security measures.
REGULATION: O-2 # WINDOW DRESSING
o Banks/DFIs shall refrain from adopting any measures or practices whereby they
would either artificially or temporarily show an ostensibly different position of
bank’s/DFI’s accounts as given in their financial statements.
o Particular care shall be taken in showing their deposits, non-performing
loans/assets, provisioning, profit, inter-branch and inter-bank accounts, etc.

20. REGULATION: O-3 # RECONCILIATION OF INTER-BRANCH ACCOUNTS
AND SETTLEMENT OF SUSPENSE ACCOUNT ENTRIES
o All entries outstanding in the Inter-Branch Accounts (by whatever name called)
and/or Suspense Account must be reconciled/cleared and taken to the proper head
of account within a maximum period of 30 days from the date the entry is made in
the above-named accounts.
REGULATION: O-4 # MAINTENANCE OF ASSETS IN PAKISTAN
o Every bank/DFI shall maintain in Pakistan not less than 80% of the assets created
by it against such time and demand liabilities as specified in Part-A of Form X
(prescribed under Rule 17 of the Banking Companies Rules, 1963).
o Accordingly, assets held abroad by any bank/DFI shall not, at any point in time,
exceed 20% of its time and demand liabilities specified in the said Form X.
o All other assets financed from sources other than time and demand liabilities
specified in the said Form X shall be held within Pakistan.
REGULATION: O-5 # FOREIGN CURRENCY DEPOSITS UNDER FE 25-1998
o Banks shall not invest deposits in foreign currency/local currency denominated
instruments below investment grade. Neither, shall they invest/place such deposits
in fund management schemes of other banks/DFIs/NBFCs whether in Pakistan or
abroad.

21.  Financial liberalization is basically a multidimensional
and gradual process.
 It adverts to a reduction of some form of regulation on
the financial industry of a given country.
 Financial liberalization postulates dismantling the
restrictions on the domestic financial markets.
 Financial liberalization refers to measures aimed at
diluting or dismantling regulatory control over the
institutional structures, official documents and
activities of agents in different segments of the
financial sector (Chandrasekhar, 2004 & Gosh, 2005).

22. Governments (institutions)
Borrowers (firms)
Investors (households)
Financial institutions (Intermediates)

23. Financial reforms are normally broader in scope
Capital Account Liberalization
 Banking Sector Liberalization
 Stock Market Liberalization
Full
 Partial
 None

24.  The financial scheme in Pakistan remained largely undiversified and
inefficient due to Big number of losses, Poor governance, Low quality of
services, High intermediation cost, Non performing loans, and Inadequate
capitalization.
 To remove these inefficiencies the Government of Pakistan undertook financial
reforms as part of a wider operation of STRUCTURAL ADJUSTMENT
PROGRAMS (SAP) in the early 1990’s to strengthen its financial system and
to provide an adequate macroeconomic environment.
 The reforms were undertaken due to some causes like:
To develop capital markets
Strengthen the health and competitiveness of banking system
Create an environment for financial institutions and markets to improve
their governance
Develop system for Credit Management
Avoid bank insolvency
promote the growth of a secondary market
Improve the prudential regulations and supervision
Allow free entry of private banks in the financial market

25.  The financial reforms in Pakistan have been
implemented in phases.
 First phase of financial reforms covers the period
1988 to 1996
 Second phase of financial reforms spans from 1997
to 2001
 The third phase of reforms covers the period from
2002 to 2004
 The capital market was also targeted. Several
changes were made in its structure to move the flow
of investment funds to more productive units.

29. The effects of bank regulations, competition and financial reforms on
Banks' performance
AUTHORS:
Sami Ben Naceur
Mohammed Omran
The Effects of Bank Regulation on the Relationship Between Capital
and Risk
AUTHORS
ALESSANDRA TANDA
The Effects of Supervision on Bank Performance: Evidence from
Discontinuous Examination Frequencies
AUTHORS
Marcelo Rezende
Jason J Wu